How These 3 Qualities Affect Your Investment Property’s Return

What makes a great commercial investment property great? What characteristics make a bad property bad? When investing in commercial property, there are about a thousand things to consider. If it’s your first property, it all can be a little overwhelming. Each property is unique and has its own strengths and weaknesses. However, there are some common traits that you should look for to ensure your success and profits for years to come. The three areas we are going to dive into are the tenant, or whomever occupies your property and pays you rent, the location of the property, and the lease terms of each tenant that rents from you.

Who's Paying You Rent?

The strength of the tenant (or tenants) paying you rent (their creditworthiness) should be at the top of the list of things you are looking for. The risk/reward profile of who occupies space in your investment property is up to you and your appetite for risk. After all, the tenants are your primary source of cash flow - you want this number to be positive, right?!

If you are considering a retail investment property, investigating the brand concept and who is operating the business will help you get more comfortable with the tenant. Is the tenant a national brand (Taco Bell, Aspen Dental, Verizon) or a local or regional concept “mom and pop” shop (local nail salon, single location coffee house, owner operated women’s boutique)? If the concept is a national brand, the next level of reconnaissance is finding out if it is a corporately operated location or franchisee operated. I think this goes without saying, but if you can have the financial backing of an entire corporation versus a single person (franchisee) operating a handful of units you would want that. If your tenant is a franchisee - how many units do they operate? How do their sales compare with other similar units? Most of this information will be available for you in the Offering Memorandum for the investment property. The broker you are working with should also be able to give you a little back-story on the property of interest, and the tenants that occupy it.

Location, Macro to Micro

Market selection

Not only does the location within each market matter, but picking a market that you are comfortable with is also an important consideration. Most of the first time investors I engage with opt to have the location of their investment property in the same city in which they live. The reasons for this are that if something goes wrong, they can easily drive to the property and fix it. From my personal experience as an investor, and knowing other investors – this is hardly the case. The property owner rarely does maintenance on the property, and any large maintenance event will require the expertise of a professional who either the owner or property management company will engage. It is nice to be able to drive by the property and have local pride of ownership. Depending on where you live though, you might have to also consider a few nearby markets. Having the most deals to pick from is where you want to be. This let’s you compare the strengths of certain deals, and will solidify in your mind that you are pursuing the best property.

When selecting a market to invest in, the questions you should be asking yourself are: who are the largest employers in the market? What is the likelihood that they would downsize or leave? Is the market population growing or shrinking? To help illustrate this point, I’ll use the market of Springfield, Missouri as an example. (I’m actually writing this article while on a site tour in Springfield. I’m investigating the strength of the Battlefield Road retail corridor, and a property located there. More on this below!) The size of the Springfield metro is great, a little under half a million people. It grows steadily each year by about 0.5% (the national growth rate is 0.7%) All in all, not a bad market. Being in the Midwest, it is insulated from some of the volatility of being on the coasts.

Sub-market

Once your market is selected, the position of your property in it’s respective sub-market and corridor is equally important. Is there synergy between the tenant(s) in your property and the neighboring retailers? Within this specific trade area, what are the market rents? How much vacancy is in this sub-market, and is the vacancy in desirable locations (a.k.a. end-caps, hard corners, high traffic/high visibility spots)?

Continuing from my example of Springfield, MO – the hottest retail corridor in town used to be Battlefield Road. The property I am investigating (while on my site tour) is located on Battlefield Road. After driving this corridor, it was clear that a divergence was taking place. New developments, such as Lucky’s Market, DSW and Homegoods on Glenstone Avenue were pulling tenants this direction. There are some high profile location vacancies on Battlefield Road that really highlight the demise of this corridor. This isn’t looking good for the subject investment property I’m looking at! Other notable vacancies on Battlefield Road at prime locations aren’t helping things either. The asking rents at these prime locations are well below what the current tenants are paying at the subject property I’m investigating. Now, this isn’t a deal killer depending on the price one would pay for the property. The big question now is, would someone want to own a retail property on Battlefield Road with these vacancies and divergence happening?

Site details

How visible from the road is the subject property? What is access in and out of the property like? What is the size of the property and can it support other building layouts? These are some of the questions you need to ask yourself. As a former business owner, I can attest to visibility not being the only characteristic you need. I owned a retail store that was directly across from the entrance to a regional mall. One would think that this would be a fabulous location (I did!). The flip-side of this, was yes – it did have great visibility, but the access was lackluster. You could see it, getting to it was a different story (you couldn’t left turn onto the frontage road that led to this property). Parking here was also a little clunky. There were parking spots right in front of the property, but the way the lot was designed made getting in and out of a stall more work than it should’ve been.

Knowing that tenants that occupy your (retail) building might not be the same ones there when you sell it is something you should keep in mind. There could be the opportunity in the future of scraping the site of the existing structure, and developing a new building for a national credit tenant. Or maybe the structure stays the same and there is an opportunity to add a coffee kiosk in the parking lot to generate extra revenue. If coffee has fallen out of favor, maybe a local or national bank would like to install an ATM due to your superior visibility from the road.

Lease Details

Beyond the fact that the tenants of your investment property are paying your mortgage, taxes, and maintenance (assuming a triple net lease) are the intricate details of how long they commit to leasing from you. What happens to them if they leave early? How does their lease rate and terms compare to other similar tenants in nearby markets, etc? Understanding the implications of how a lease is structured plays a huge role in who has the more favorable position in each lease. While working with your broker and attorney you’ll come to understand how strong the lease is between you, as the landlord, and them as a tenant.

Other questions this brings up are: Is it a triple net lease? How much term is left? Are the rents above/equivalent/below market rates? Are the rents consistent with what other locations in similar markets paying? Are there rent increases in place throughout the term of the lease? Who is guaranteeing the lease?

Wow, that’s a lot of information!

You are correct. That’s why successful commercial investors team up with commercial brokers and look at properties and their current cap rates frequently to see how each deal stacks up to other deals out there. If you’re interested in investing in commercial real estate (retail, multifamily, office or industrial) in Omaha or the Midwest – send me a DM or leave a comment below, I’m more than happy to help!

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